Why this rare British tech success has a competitive advantage for investors

Questor says despite challenging times, Sage still expects profit margins to rise

Questor is The Telegraph’s stockpicking column, helping you decode the markets and offering insights on where to invest for the past six decades.
Investors who expect interest rate cuts to provide a sudden boost to the economy’s growth rate are going to be sorely disappointed.
Even though the Bank of England is forecast to reduce interest rates by around 120 basis points over the next two years (and the Federal Reserve now expects to slash interest rates by 200 basis points by the end of 2026) monetary policy easing will take some time to have its desired impact on economic activity.
Indeed, the existence of time lags, which can last for up to 18 months following interest rate changes, means that the near-term prospects for FTSE 100 Sage are somewhat uncertain. The provider of payroll, finance and accounting technology, which relies on small and medium-sized businesses for its sales, could struggle to both raise prices and increase the take up of its products if its customer base experiences a period of weak profit growth.
The firm already moderated its financial guidance at the time of its half-year results in response to an uncertain operating environment. It subsequently reiterated its revised forecasts for the full year in a third-quarter trading update released in July. Its anticipated organic sales growth of 9pc was slightly lower than an original forecast of a 10pc increase.
Encouragingly, though, it still expects operating profit margins to rise in the current financial year and beyond.
In Questor’s view, the firm’s capacity to deliver relatively brisk sales growth and a rise in profit margins, despite a somewhat challenging economic environment, provides yet more evidence of its sound competitive position. It benefits from a degree of inertia among its customers that results from the prospect of high switching costs. This provides scope for price rises over the long run. 
A clear competitive advantage was evidenced in the company’s return on equity figure of 23pc in its latest financial year despite it having only modest debt levels. Net gearing, for example, amounted to just 40pc at the time of its full-year results.
The company’s competitive position is being strengthened by a continued increase in the proportion of its revenues that are recurring. They rose by one percentage point to 97pc during the first nine months of the current financial year and provide a more stable financial outlook. This helps to reduce overall risk and is complemented by the company’s diverse range of products and broad geographical exposure.
While Sage faces a somewhat challenging near-term outlook due to the delayed impact of an unwinding of restrictive monetary policy, it is set to ultimately experience improved operating conditions.
Lower interest rates have historically prompted stronger wage growth, improved employment prospects and rising consumer spending over the long run that should catalyse the firm’s top and bottom lines as they boost the financial performance of its customers.
The company’s profitability could also be catalysed by further M&A activity, with its sound balance sheet providing scope for additional acquisitions following purchases over recent years. And with it benefiting from significant cross-selling opportunities as it releases new products, it is well placed to deliver relatively strong profit growth over the coming years.
In the next two financial years, the firm’s bottom line is due to rise by 14pc per annum. This growth rate fails to fully justify a price-to-earnings ratio of 31.6, which is undeniably very expensive. However, the stock’s long-term investment prospects are nevertheless appealing as it is poised to benefit from an increasingly favourable economic environment.
Since this column first tipped Sage as a “buy” in June 2021, it has produced a 48pc capital gain. This is well ahead of the FTSE 100 index’s 17pc rise over the same period and is in spite of share price weakness over recent months. Indeed, the company’s shares have fallen by 17pc in the past six months as investors have factored in a more challenging near-term outlook.
Given that Questor takes a long-term view, it is wholly unconcerned about the potential for further share price volatility or a temporary slowdown in the company’s earnings growth rate.
Sage remains a fundamentally sound business with a solid balance sheet and an excellent competitive position. Over time, and as the impact of interest rate cuts are fully felt, it is well placed to deliver further capital growth and index outperformance.
Questor says: buy
Ticker: SGE
Share price at close: 1003.5p
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